Fundamentals: ‘Heavily undervalued’ Nordic power front year unlikely to climb amid bearish signals

The Nordic power front-year contract is “heavily undervalued” as the end of 2017 approaches, according to sources.

But, with mild weather and strong precipitation forecast until late December, it is unlikely the contract will record any substantial gains ahead of the New Year.

‘Fundamentally undervalued’

The financially-settled front-year contract was valued at €24.83/MWh on Tuesday, according to data from the Nasdaq exchange. Mild and wet weather conditions have heavily weighed on the product in recent weeks, causing it to shed almost 8% of its value in December.

The Nordic system price – the physical day-ahead reference price calculated as an average of the region’s 13 zones – has out-turned at an average value of almost €30.00/MWh throughout 2017 so far, according to Nord Pool data collated by ICIS.

“Fundamentally I think the entire Cal ’18 is heavily undervalued,” one Nordic power trader said on Wednesday afternoon. “We are pricing bearish weather to continue for a very long time.”

Bearish outlook

According to the latest forecasts released by meteorologist WSI on Wednesday, temperatures across the Nordic region are set to be comfortably above average for the time of year until at least 25 December.

Temperatures as much as 6°C above seasonal norms are expected across large parts of the north and northeast of the region.

Deviations in temperature can be a key driver of the Nordic power market throughout the coldest months of the year due to prevalence of electric heating across the region.

Further weakness for near-curve prices is likely to stem from high levels of precipitation in the coming week, with forecasts indicating precipitation around 50% above normal until the end of December.

Heavy rain and snowfall will weigh on curve contracts by limiting the depletion of the region’s hydroelectric reservoirs. With the front year now close to expiry, it can also be influenced by very bearish weather, although to a lesser extent as only the first one or two of its component months will likely be fundamentally affected by the impact of weather on hydro stocks over the next fortnight.

Total hydro stocks have been well above last year’s levels since the start of October – a factor which has lent significant downside to the Nordic near curve.

Stocks sat at 73% of their potential total on Monday, according to the latest data released by Nord Pool on Wednesday. This is over 10 percentage points higher than at the same time in 2016.

German support

“The Cal is also supported by a still-strong Germany,” a second trader said in reference to a comparatively firm German front-year product.

The source said the Nordic front-year could be valued even lower than its current level if neighbouring markets had not limited losses.

The over-the-counter German Year 2018 Baseload contract was assessed by ICIS at €37.70/MWh at Tuesday’s close, giving it a substantial €12.85/MWh premium over the equivalent Nordic product. This has risen since early September in particular, when a disconnect between the two country’s front year’s set in (see graph).

Sources have in recent months cited the spread between the Nordic market and the physically connected German market as an indicator that Nordic prices could climb.

However ongoing bearish weather conditions across Scandinavia have largely insulated prices at times when mainland-European prices have been bullish.

The region’s heavy reliance on hydroelectric generation, power from which meets over half of Scandinavian demand, means the Nordic market is typically fundamentally comfortably supplied compared to neighbouring countries. christopher.somers@icis.com